Expectations of 2014 interest rate rise gather further pace

Asset manager Standard Life Investments is the latest firm to call time on the UK’s prolonged period of ultra low interest rates.

It says the the Bank of England (BoE) should look to tighten policy using a combination of monetary and “macro-prudential” tools, or else risk greater volatility further down the line.

James McCann, UK and European economist at the firm said: “The BoE has been granted a broad swathe of new macro-prudential powers in the wake of the financial crisis. The hope is that this new institutional setup will prevent a re-run of mistakes made in the recent past when a long period of economic stability masked the growth of significant financial imbalances in the UK.

Bank of England governor Mark Carney

“With the current recovery proceeding impressively and property markets accelerating we believe that the Bank should flex its muscles sooner rather than later.”

McCann added however that while it is not yet time to remove the punchbowl of accommodative policy, it looks “increasingly appropriate to water down this intoxicating mixture”, and he believes the BoE should raise rates later this year if spare capacity continues to shrink and financial conditions do not tighten sufficiently.

He added: “By starting early and moving gradually the BoE would be in a stronger position to calibrate the pace and scope of tightening. There is growing evidence that the MPC is moving in this direction following Mark Carney’s Mansion House speech. We would urge the committee to follow through on this signal, with the balance of risk pointing to a gradual move away from an emergency policy setting.”

In a note issued this week, Schroders European economist Azad Zangana said: “The minutes from the latest BoE Monetary Policy Committee (MPC) meeting warn that there is a rising risk that interest rates may have to rise in 2014 – sooner than the financial markets were expecting. The meeting minutes revealed that early indicators of economic activity had been stronger than expected, and so the Bank’s central view that the economy may slow in the second half of the year may prove to be too pessimistic. Therefore, the minutes state that “In that context, the relatively low probability attached to a Bank Rate increase this year implied by some financial market prices was somewhat surprising.”

Bank governor Mark Carney provided a preview of the change in tone to a more hawkish stance in his Mansion House speech, when he warned that the first rise in interest rates “…could happen sooner than markets currently expect,” says Zangana.

Howard Archer, chief UK & European economist at IHS Global Insight also believes that it is looking increasingly likely that the BoE will edge interest rates up before the end of 2014. He said; “While interest rates are likely to rise only gradually and by a limited amount, this may well also have some dampening impact on the housing market.”